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SSE - Dividend ticks up again

George Salmon | 17 May 2017 | A A A
SSE - Dividend ticks up again

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SSE plc Ord 50p

Sell: 1,665.50 | Buy: 1,666.50 | Change 15.00 (0.91%)
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For the year to 31 March 2017, SSE has reported an adjusted earnings per share of 125.7p, up 5.2% on last year. As per the group's stated target, the full year dividend has been increased in line with RPI, up 2.1% to 91.3p per share. The shares fell slightly on the news.

Our View

SSE's dividend has grown every year since 1992, at a compound annual rate of almost 10% per annum. Against that background the prospective yield of 6.5% is an undeniable attraction. However, in order to sustain dividend growth in the long run, we feel the group's profits and cash flows must improve.

Target dividend coverage has dropped from 1.5x to 1.2-1.4x, and while SSE's free cash flow (cash available after interest costs and capital expenditure, but before disposals) just about covered the dividend this year, that's something of a rarity. Over the last three years, total dividends have exceeded free cash flow by more than £400m.

SSE has committed to spending in the region of £6bn in the 4 years to March 2020, so cutting back spending in order to free up cash doesn't look likely. In order to improve things then, it will need to find a way to improve operating cash flows. Over the last seven years, not much progress has been made. Indeed, despite the group spending well over £10bn on capital expenditure in this time, net cash generated from operations hasn't moved a great deal.

Around half of expenditure will be directed to the more volatile Wholesale and Retail operations. The outlook here has been further clouded by falling retail customer numbers and Theresa May's plans to cap energy prices.

The other half is going into the Networks division (electricity and gas distribution), where returns are set by the regulator. In theory this investment should lead to steady and reliable growth in cash flows. This division is the jewel in SSE's crown and its steady cash flows help support the dividend. But it only accounts for around 50% of profits, and the group has also relied on asset disposals, debt, and share issuance to prop up the payout. Clearly this can't go on forever.

The big question is therefore whether the long term investments SSE is making will lead to significantly higher cash flows in the future. If they can't, its generous dividend policy might need to be revisited.

Full year results:

Reported numbers were boosted by the exceptional charges SSE took on wholesale generation, gas storage and production assets in 2015/16. Adjusting for these gains, 2017/18 operating profit of £1.9bn was up 2.7%.

  • Within the group's divisions, the regulated Networks business contributed £936.5m to adjusted operating profit (up 1%) with gains in Electricity Distribution more than offsetting lower profits in Transmission.
  • The Wholesale division contributed £514.6m, up 16%. This was boosted by an improved financial performance in thermal generation and Energy Portfolio Management.
  • Adjusted operating profits in the Retail business fell 7% to £422.3m. SSE now has 8m gas and electricity customer accounts across the UK and Ireland, down 210,000 on last year.

Adjusted net debt was £8.5bn at year end, up slightly on 2015/16, while investment and capital expenditure rose 6.6% to £1.7bn. The bulk of this spend was in electricity networks and renewable energy. The group expects a similar level of expenditure in 2017/18, as part of plans to invest £6bn over the four years to 2020.

SSE continues to target annual dividend increases that at least keep pace with RPI inflation, with the payout covered 1.2 -1.4 times by earnings. As previously disclosed, 2017/18, coverage is likely to be towards the bottom end of guidance.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.